Reserves of top stablecoins

This graph from an IMF blog neatly summarises the considerable diversity in the asset backing of stablecoins. While the IMF blog highlights the risks associated with stablecoins, I prefer to remain open to the possibility that they represent a new vector of competition that will force traditional banking to lift its game.

That possibility does however (for me at least) require that the banking regulators develop a stablecoin regulatory model that is fit for purpose. I am yet to see any jurisdiction that appears to be offering a good model for how this might be done but welcome any suggestions on what I am not seeing.

In the interim, JP Koning did a good post summarising the regulatory models he saw being pursued by stablecoin issuers.

Tony – From the Outside

M-Pesa and the African Fintech Revolution – by Marc Rubinstein – Net Interest

You, like me, might be vaguely aware of the M-Pesa story of fintech innovation in Africa. Marc Rubinstein offers one of the best accounts I have encountered of how this came about and where it might be headed. Especially interesting is his analysis of why it took off in Kenya and the challenges it has faced in other markets.

You can find Marc’s post here –

Tony – From the Outside

Finance cartels face digital currency shake-up | Financial Times

Cross border payment is one of the areas of conventional banking where challengers believe that crypto/DLT solutions can shake up the existing order. There is little doubt that the cross border payment status quo has lots of room for improvement but Gillian Tett (Financial Times) offers a nice summary of central bank projects that are potentially introducing other vectors of innovation and competition.

— Read on

Why is the United States lagging behind in payments?

… is the title of a useful paper by Christian Catalini and Andrew Lilley that digs into the puzzle of why it is that one of the (if not the) key players in the global financial system seems to lagging global best practice in terms of the cost, convenience and speed of its payment system.

It has to be noted that the authors are not neutral observers in this space. Christian Catalini is the Chief Economist of the Diem Association and Diem Networks US, and Co-Creator of Diem (formerly Libra). He is also the Founder of the MIT Cryptoeconomics Lab and a Research Scientist at MIT. Andrew Lilley is an employee of Novi Financial, Inc. who contributed to the paper as part of his work with Diem Networks US. With that caveat in mind, the paper still offers a short (12 pages) and useful summary of the ways in which the US lags best practice.

They frame the US problem as follows:

The US enjoys one of the least concentrated banking systems among the G30, but this feature has also created a fragmented and expensive payments system. Transfers between major US banks incur fees ranging from $10 to $35 for same-day wires, and up to $3 for 2-day transactions. Compare this to the UK, where individuals and businesses have access to a free, 24/7 interbank payments system which settles within seconds and supports over 8M transactions per day. While the US does have a Real Time Gross Settlement (RTGS) system, the Fedwire Funds Service carries less than 1 million transactions per day, has limited 21/5 availability, and is almost exclusively used by financial institutions and large corporations. Its fees, moreover, are larger than alternative payment methods such as ACH, creating a trade-off between cost and immediacy. Private sector alternatives are limited, and while some banks have deployed real-time solutions, these come with transaction limits and little adoption, which severely reduces their usefulness.

Catalini and Lilley (2021), Why is the United States Lagging Behind in Payments?

The paper then outlines how these limitations affect individuals, business and government and concludes with suggestions of what might be done to address the problems discussed:

There are at least three ways to remove frictions in payments and rapidly expand the number of individuals and businesses that can access the financial system and cheaply transact in real time. The first is to bring deposits on a single ledger through a Central Bank Digital Currency (CBDC), so that transfers between banks are not limited by external liquidity constraints or third-party rails. The second approach is to follow countries such as India and Mexico and increase the throughput of always-on RTGS systems. This is the model the Federal Reserve is pursuing with the introduction of FedNow, targeted for 2023. FedNow, however, is expected to have an initial transfer maximum of $25,000, which would limit its usefulness to businesses. The third approach is to facilitate the growth of interoperable, stablecoin payment rails by creating the right regulatory framework for these new types of networks to safely increase competition in payments.

While each one of these approaches presents different challenges, opportunities and trade-offs in terms of complexity, development costs and ability to expand access to segments that are currently excluded, it is important to stress that they are likely to be complements, not substitutes.

Advancing the US payments infrastructure will require both regulatory and technical developments targeted at improving market structure, lowering barriers to entry, and facilitating collaboration between public and private sector efforts in digital payments.

Catalini and Lilley (2021)

I am trying to keep an open mind on the future of payment systems but find myself drawn towards the conclusion that fast payment systems that the FedNow initiative is based on seem to have worked pretty well in other countries in terms of improving cost, speed and convenience so it is not obvious to me why either a CBDC or stablecoin solution is necessary in the United States.

If you want to explore these issues further, JP Koning recently offered a nice summary of what has been achieved by fast payment systems in other countries while a speech (“CBDC: A solution in Search of a Problem?”) by Governor Waller of the US Federal Reserve neatly summarises the issues associated with whether a CBDC is necessary or desirable (at least so far as the USA is concerned). It is important to recognise however that the conclusions that Waller draws do not necessarily apply to other countries (China being the prime example) which are responding to very different types of payment systems.

Let me know what I am missing

Tony – From the Outside

Progress in fast payment systems

As we contemplate new forms of money (both Central Bank Digital Currencies and new forms of private money like stablecoins), JP Koning makes the case that the modern payment systems available in the conventional financial system have improved more than is often appreciated …

The speeding up of modern payments is a great success story. Let me tell you a bit about it.To begin with, central banks and other public clearinghouses have spent the last 15-or-so years blanketing the globe with real-time retail payments systems. Europe has TIPS, UK has Faster Payments, India has IMPS, Sweden has BiR, Singapore FAST. There must be at least thirty or forty of these real-time retail payments system by now. 

The speed of these new platforms get passed on to the public by banks and fintechs, which are themselves connected to these core systems.

That is not to say they are perfect but it is helpful to properly understand what has been done already in order to better understand what the new forms truely offer.

You can read his post here ..

Tony – From the Outside

The meltdown of IRON

Kudos to “Irony Holder” for a great title to an equally interesting post exploring what went wrong with the IRON stablecoin. My last post “A bank run in CryptoLand” flagged a short summary of the demise of IRON in Matt Levine’s Money Stuff column in Bloomberg and Matt’s latest column put me onto Irony Holder for a more detailed account of what went wrong. I suspect that I will be returning to the stablecoin topic many times before I am done.

One of the challenges in banking and finance is figuring our what is “new and useful” versus what is simply a “new way of repeating past mistakes” and stablecoins offer a rich palette for exploring this question. I remain open to the possibility that stablecoins will produce something more than a useful tool for managing trading in cryptoassets. The potential to make low value international payments cheaper and faster seems like one of the obvious places where the existing financial system could be improved on.

However, it seems equally likely that stablecoin innovation will repeat mistakes of the past so these post mortems are always useful. I recommend reading Irony Holder’s account in full (especially for the code error in the smart contract) but this is what I took away:

  • Part of the problem with IRON seems to be that the developers prioritised “efficiency”. In my experience the pursuit of efficiency has an unfortunate tendency to result in systems that are neither robust nor resilient – two highly desirable qualities in anything that facilitates the transfer of value. That observation (“efficient is rarely if ever resilient”) is of course based on the hard lesson that the conventional financial system learned from way it operated in the lead up to the Global Finance Crisis.
  • Algorithmic stablecoins like IRON appear to down play, or avoid completely, the need for high quality collateral. Experience in the conventional financial system suggests that collateral (ideally lots of it) is a feature of robust and resilient payment systems.
  • Yield farming around the IRON-USDC pair was producing extraordinary returns. High returns are a feature of the crypto asset world but maybe high returns on a stablecoin should have been a red flag?

I have over four decades of experience in the conventional financial system but I am a “noob” in this space (crypto-DeFi-digital) so the observations above should be read with that caveat in mind. It also important to remember that the issues above do not necessarily extend to other types of stablecoin. My understanding is that the algorithmic approach has not achieved as much traction as fiat and crypto collateralised approaches.

Hopefully you find the links (and summary) useful but also tell me what I am missing.

Tony – From the Outside

Central bank digital currency

Izabella Kaminska (FT Alphaville) offers another perspective on what the development of a Central Bank Digital Currency CBDC) by the People’s Bank of China means for China itself, the rest of the world and the USD in particular.

Her column is titled “Is the central bank panic about the PBOC coin justified?”. It is not clear that central banks are actually panicking at this stage (equally I am not sure that Isabella has 100% control over the titles her sub-editors apply to her articles). The article does however offer some balance to the narrative that sees China’s moves in this space forcing other central banks to follow suite.

I am yet to fully come to terms with the questions posed in her article but this (for me at least) is definitely an area to watch and seek to understand.

Izabella has been a reliable source of insight on this and the broader questions associated with the increased role of fintech in our payment systems. I can also recommend a column she wrote in July 2019 titled “Why dealing with fin techs is a bit like dealing with pirates”. A paper by Tobias Adrian and Tommaso Mancini-Griffoli titled “The Rise of Digital Money” is also worth reading if you are interested in this topic (one of my posts offers a short overview of the paper and a link to the original).

Tony – From the Outside